Charitable giving tax deduction – how to maximize your tax savings

Whether it’s #GivingTuesday, your alma mater, or any other reason for making a charitable donation, we couldn’t be prouder of you for doing so. But while you’re at it, let’s make sure we get the most out of that charitable deduction on your tax return.

This article summarizes some of the best tricks for maximizing the tax savings from your charitable giving. If you need a primer first though on the mechanics of the charitable tax deduction, start here with our basic overview article.

1. Donate Stocks, not Cash

If you have appreciated stocks in your brokerage account (we’re not talking about a 401(k) or IRA), then we can’t overstate how savvy of a tax move it can be to donate stock to your favorite charity instead of cash.

Here’s a quick example to illustrate how this works. Let’s assume you’re donating $100, and you’re choosing between giving cash or one share of stock worth $100 that you originally purchased several years ago for $50. The share of stock has a $50 unrealized gain, which is going to have about a $7.50 tax liability when sold (assuming a long-term capital gains rate of 15%). Even though you might not plan on selling that stock right now, if you sell it in your lifetime, that unrealized gain is going to have an associated tax bill. If instead, you donate the stock, you can correspondingly take the $100 of cash that you would have donated and repurchase the same stock, resetting your cost basis to $100 and eliminating any unrealized capital gain. You just saved yourself $7.50, or 7.5% of your investment return.

Donating stocks doesn’t impact the ability to deduct the donation for tax purposes either, so there’s a double benefit to donating stocks. This is a great strategy for anyone with a stock portfolio that has had gains.

2. Bunch Gifts into Single Year

One of the most significant changes introduced in 2018 under the new Tax Cuts and Jobs Act was the increase of the standard deduction. This increase means that many taxpayers won’t itemize their tax deductions every year. Check out our charitable giving primer to understand the tax implications of itemizing vs. taking the standard deduction.

For these taxpayers, bunching is a strategy where a taxpayer groups their deductions into a single year so that the total of all itemized deductions will exceed the standard deduction in that particular year. Then, in the following year when the taxpayer has fewer deductions, he/she benefits from taking the higher standard deduction instead.

Let’s look at another quick example. Sam is a single taxpayer with $10,000 of state income taxes and no other itemized deductions other than her charitable giving which is typically $2,000 per year. The standard deduction is $12,000, so she has a choice between itemizing or taking the standard deduction, depending on her income level. However, if she bunches two years of charitable giving into the same year, thus giving $4,000 this year and $0 the next, she gets to itemize $14,000 in one year and still $12,000 in the other. She has increased her total deductions by $2,000, which at a 35% marginal tax rate, is worth $700 in tax savings, as well as giving to donations to her chosen charities.

Understanding your specific situation is critical to knowing whether bunching could make sense to you. Consult a Visor tax advisor to determine if you might be able to benefit.

3. Consider Opening a Donor Advised Fund (especially if bunching)

A Donor Advised Fund, or DAF, is a vehicle that allows donors to make a charitable donation and receive an immediate tax deduction while supporting charities on a flexible schedule.

A DAF can be set up with brokerage firms, mutual fund companies, or community foundations. The money is donated and then invested until the decision is made as to which charity it will be given. The donation is irrevocable, so you can’t change your mind later, but the benefit is that you can claim the full deduction now even if you aren’t yet ready to allocate the gifts out to particular charities.

Donor Advised Funds can be very effective vehicles for taxpayers in two situations: (1) taxpayers looking to take advantage of the “bunching” strategy outlined above, or (2) taxpayers with large one-time income events, such as startup founders, who want to offset a big chunk of that income by donating a significant portion while at the same time taking advantage of the deduction before making the final decision of charitable cause to donate to.

Consult a Visor tax advisor if you think a DAF might make sense for you.

Key Takeaways

The tax deduction for charitable donations is well-known but widely misunderstood. The key first step is understanding whether you will take the standard deduction or itemize on your tax return each year. Based on that information, you can decide which of the above strategies makes most sense for you. While the tax deduction surely isn’t the main driver for your giving, there’s nothing wrong with maximizing the tax benefits associated with your donations and doing so takes some forethought.